APY vs APR: What’s the Difference?

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The acronyms APY and APR sound similar, but they’re quite different. We’ll break down the differences between APY vs APR and explain how they impact you when you borrow and save money.

What Is APR?

APR, which stands for annual percentage rate, usually represents the total cost of borrowing on an annual basis expressed as a percentage. APR takes into account the interest rate and any additional fees incurred to get a loan.

For example, if you get a new home loan, the APR will encompass not just the interest charged by the lender, but also any origination fees, closing costs, or other expenses associated with securing the loan.

Basically, APR gives you a broader picture of the overall cost of borrowing than just the interest rate.

You may also see APR quoted on savings or investments. In this case, the APR is simply the interest rate you’re earning on your money. But, as we’ll see in the next section, APR is not necessarily an accurate reflection of what you’re actually earning.

This is why it’s important to understand the differences between APY vs APR.

What is APY?

APY, which stands for annual percentage yield, represents the total return you receive on your savings and investments, including compounding.

APY more accurately reflects how much you’ll earn on savings and investments than the quoted return.

To understand this better, let’s assume you put $10,000 into a savings account earning 5% for one year. At first glance, you might assume that at the end of one year, you would have $10,500, right?

Not quite!

Savings accounts usually compound monthly, which means interest is added into your account on a monthly basis. The new balance is then used to calculate the interest you’re owed for the next month. You’re earning interest on interest!

That’s what compounding is all about – and that’s what APY takes into account. When you figure in the compounding, your ending balance after a year is $10,511.62.

You earned 5% on your savings, but because of the monthly compounding, your APY is actually 5.12%.

If you’d like to do your own calculations, you can find a great compound interest calculator here.

APY vs APR

Let’s sum up our explanation of APY vs APR: APR represents the total cost of borrowing, including interest rate and any fees associated with getting a loan. This is why the APR on a mortgage loan is often higher than the interest rate.

APY, on the other hand, represents your total return on savings and investments, including the effects of compounding.

If you put money in the bank, it will likely compound each month. In other words, the interest you earn is added to your account balance on a monthly basis and used to calculate your earnings for the next month.

APY takes into account the effects of compound interest, which is why APY is often higher than the interest rate you’re earning.

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Frequently Asked Questions

Is it better to earn APR or APY?

When considering APY vs APR, it’s important to understand they’re typically two very different things. APY refers to the total yield you’re earning on savings or investments, including the effects of compounding. APR refers to the total cost of borrowing on a loan, including the interest rate and any fees associated with getting the loan.

Why is APY higher than APR?

When evaluating your returns on savings and investments, it’s important to understand the differences between APY vs APR. APY is typically higher because it takes into account the effects of compounding. For example, if you put $10,000 into a savings account earning 5%, you’ll actually end the year with $10,512. Your APR was 5%, but your APY ended up at 5.12% because of the monthly compounding.

What does 7% APY mean?

If you’re getting a 7% APY, that means you’re earning 7% on your money over the course of a year when taking into account the effects of compounding. Assuming monthly compounding, the annual interest you’re earning would actually be around 6.78%. But when you take into account the effects of monthly compounding, your actual annual yield is 7%, which is represented by the APY.

Mike Roberts
About Mike Roberts

Mike Roberts is the founder of HEAZone.com, a published author, and a highly experienced veteran of the mortgage industry. When he's not working, he enjoys spending time with his family, skiing, camping, traveling, or reading a good book. Roberts is the author of The Reverse Mortgage Revealed: An Industry Insider’s Guide to the Reverse Mortgage, which is available on Amazon.